The Upside of a Down Market: At Least It's Not a Bubble

There are a lot of bubbles bruited about these days. At a recent forum on housing price inflation, experts spoke of a Chinese credit bubble, an agricultural mortgage bubble, even a bubble in Fannie Mae's stock price.

But a national housing bubble popping here in the United States? Doubtful.

Certainly there has been a run-up in real estate prices since the collapse. But the general feeling among panelists at the American Enterprise Institute event in Washington was that the dim outlook for this year is not one that would encourage additional frothiness.

The funniest bubble was the Fannie Mae equity one, put forward by former Mortgage Bankers Association chief economist Jay Brinkmann. Mark Carey, a senior adviser for international finance with the Federal Reserve, talked about the ag mortgage bubble. And Desmond Lachman, a fellow at AEI, briefed the crowd about emerging markets internationally, including the frothy Chinese credit market.

Fannie Mae stock, currently trading at about $3.60 per share, has seen some smart appreciation since its days as a penny stock, as investors have speculated it may re-emerge from federal conservatorship and become a private company again.

Not so fast, says Brinkmann, who doubts the company could stand on its own.

"I've pretty much concluded Fannie Mae now is the world's most expensive insurance agent," Brinkmann said. How so? "The federal government is putting up all the capital supporting the ongoing business. They would not be able to sell a single mortgage-backed security without that kind of support given the capital levels they have." The company has $9.5 billion in capital against assets of $3.2 trillion, or a miniscule 0.29% capital ratio, by Brinkmann's calculation.

"What does Fannie Mae do with its 7,000 employees?" he asked. "They market the insurance. They evaluate the counterparty risk. That's the same claim on the dividend as an Allstate agent saying 'I sold that, I should get the proceeds,' rather than the company itself."

Brinkmann also contested the company's claim that it has paid back to the Treasury, in dividends, $5 billion more than it has received in bailout money. Actual and implied support is more like $280 billion, he said.

"Has that been paid back? No. what Treasury was really trying to do was to keep the capital base from going negative," he claimed.

The Fed's Carey identified farm mortgages as a current bubble but asked, "What are you going to do about it? Deflating a bubble, how do you do it? Price setting is a very difficult thing to do."

The recent run-up in ag loans (which would support higher land prices) has been centered in the Farm Credit System, specialized lenders who make farm loans but do not take deposits, instead getting funds at federal agency rates, Carey noted.

He called the farm bubble "a debt finance bubble," with "essentially all the run up" coming from FCS lenders (other lenders in the space include commercial banks and life insurers). The problem is an implicit federal guarantee, he said, with the result being that the FCS co-ops have been inattentive to risk.

FCS "did not learn the lesson of the last bubble" of the 1980s, he said.

Home prices were up 12% last year, bringing the country back to roughly 2004 price levels after rising for 23 consecutive months, according to the Case-Shiller index, industry analyst Chris Whalen noted.

"Home prices turn very slowly," he said, but he predicted that by the end of this year, the index will start to slow.

The Dodd Frank Act and the new Basel III standards "are discouraging banks from making loans," he said, and bank portfolios of mortgages are declining. The 20% to 30% of homes that are still underwater will depress the market as well, as their owners will not want to sell until they can cash out some equity.

Brinkmann likewise noted that purchase mortgage activity has been very weak in the first quarter, making for a "subdued" market that should not put a lot of upward pressure on national home prices.

Only panel moderator Alex Pollock, an AEI fellow who has been running housing bubble panels twice a year for the past seven years, showed any concern about overheating in this sector. The answer to whether another housing bubble is developing now is "maybe," he said.

Nevertheless he thinks he knows a way to put the brakes on any further run-up. "It's time for the Fed to stop trying to inflate house prices further and to stop buying mortgages," he said.

Mark Fogarty, Editor at Large at National Mortgage News, is starting a regular blog of analysis and commentary based on his 30 years covering the mortgage industry.